Local steel players had a tough year in FY12 as steel prices were pressured by: 1) the overcapacity of Chinese steelmakers, 2) weak demand in Europe and 3) a slower than expected growth in Asia, especially in China. So we can expect global steel prices to remain volatile. However, in the Malaysian context, we expect local players to see gradual improvement in FY13 earnings as local steel prices appears to have bottomedout and will be supported by the increasing demand  from the major construction activities under the Economic Transformation Project (“ETP”) and from the Iskandar region developments. Hence, we are maintaining our NEUTRAL recommendation on the building materials sector, specifically steel, with the following recommendations; MASTEEL (MP, TP: RM0.91) and ANNJOO (UP, TP: RM1.31). 

Disappointing 1QCY13 results.  The two steel stocks under our coverage, namely  Ann Joo Resources Berhad (“ANNJOO”, UP, TP: RM1.31) and Malaysia Steel Works (Kl) Berhad (“MASTEEL”, MP, TP: RM0.91), saw marginal improvements in their earnings for the quarter on YoY basis due to lower operating costs and better sales underpinned by the higher local demand and we would expect margins for the local players to be sustainable in the upcoming quarters. However, their 1QCY13 earnings were still disappointing as they came in below ours and consensus estimates. ANNJOO was bogged down by its high financing cost while MASTEEL was still affected by soft selling prices. 

Global steel prices remain volatile. Major developing economies like China and India will still be the vital growth drivers for the demand in the global steel industry. China has been the main factor behind the volatility in steel prices given that it is still the largest steel producer in the world, supplying c.50% of the world’s steel production. There are overcapacities which has caused a glut in supply over the last few years while demand has been subdued in China post the Beijing Olympic Games. Steel prices like HRC saw a minor recovery in early Feb-13 of 2.5% to USD622 price levels, coinciding with the long public holiday period in China to celebrate the Chinese New Year festival. However, prices trended downwards back in Mar-13 up till early June-13 at USD552 price levels due to high inventories as steel mills in China ramped up their production again after the festival period. Some Chinese steelmakers like Hebei Iron & Steel Group and Rizhao Steel have been curbing their output recently with the start of their plant maintenance in early June, which has led to steel pricesseeing some recovery back of late as the inventory levels eased slightly. However, we do not think the recovery in prices will be sustainable as the slowdown in China persists. We also expect dumping activities to start again once the steel mills are done with their maintenance. It was reported that Baoshan Iron & Steel, the biggest listed steelmaker by market value and known as Baosteel, would be slashing prices for the first time in nine months in June and is expected to cut them again in July, a move that will slice its razor-thin margins further. Hence, we expect the global steel prices to continue to be volatile in the medium term with further downside and only stabilise if construction activities in the developing nations in Asia, particularly in China and India were to rebound. This does not bode well for upsides in local steep prices. 

Strong local demand will cushion downside risks. Local steel prices remains subdued and we reckon that the strong local demand underpinned by the execution of major construction projects under the Economic Transformation Project (“ETP”) i.e. MRT, LRT, Tun Razak Exchange, Iskandar region development and etc. will continue to support the demand for local steel. We expect the busier construction activities in 2013 which will also help to pare down our local steel millers’ high inventory levels although their bottom line growth  will still be limited due to their current high holding cost. So, 2013 earnings will likely show gradual improvements to 2012. 

Valuation and recommendation. We are maintaining our NEUTRAL call on the building materials sector due to the unfavourable demand-supply dynamics. Currently, we are basing MASTEEL and ANNJOO valuations at trough levels. As such, we have the following recommendations;  1. MASTEEL (MP, TP: RM0.91) is a more efficient player due to its smaller-scale size which bodes well as they purely cater for the local market. Our TP implies a downside of around 8%.  2. ANNJOO (UP, TP: RM1.31) due to high financing costs arising from its earlier plant-ups and ironically, is resulting in higher fixed cost given excess capacity as they are operating at 78% plant utilisation rate. Our TP implies a downside of around 2%.

Source: Kenanga